Private Credit
Also known as: Direct lending, Private debt
The shadow banking success story: funds replaced banks as lenders to the buyout world — $2 trillion and counting.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat is it, really?
Private credit is lending done by funds instead of banks. A fund manager collects money from pensions and insurers, then goes to a company and negotiates a loan with it directly. The borrowers are usually mid-sized firms, and usually ones a private equity fund already owns. Banks used to make these loans. After the rules were tightened following 2008, they largely stopped wanting to.
The loans pay a floating rate: a benchmark rate that moves with central-bank rates, plus another 5–7% on top. They rank ahead of other lenders if things go wrong, and they come with real conditions the borrower has to keep meeting. In recent years that has added up to 10–12% a year, which is why so much money went in. Fifteen years ago this was a corner of the market. It is now around $2 trillion, and in some parts of the market the biggest managers — Apollo, Ares, Blackstone — now lend more than the banks do.
Three things are given up in exchange. You cannot sell: there is barely any second-hand market for these loans. You cannot check the price: nobody trades them, so the value you are shown is the lender's own estimate. And you cannot look up the track record, because there isn't a full one. The industry has never been through a proper wave of defaults at anything like today's size, so how much is really lost when things turn is still an open question.
- Asset class
- Private markets (debt)
- Instrument type
- Directly negotiated loans / fund stakes
- Traded
- Not traded; hold to maturity
- Typical users
- Insurers, pensions, BDC shareholders
3 · IntermediateHow it works in practice
The product shelf
- Direct lending: senior secured loans to mid-market/sponsor-backed firms — the core.
- Unitranche: one blended facility replacing senior + mezzanine — simpler, bigger, the signature instrument.
- Mezzanine/junior, special situations/distressed, asset-based finance (receivables, equipment, royalties — the current growth frontier), and NAV lending to funds themselves.
- Wrappers: drawdown funds for institutions; BDCs (listed, US) and semi-liquid evergreen funds for private wealth — the retail frontier, with liquidity promises worth reading twice.
Why borrowers pay up
Speed and certainty (one lender, no syndication risk), confidentiality, covenant flexibility negotiated bilaterally — worth 100–300bp over syndicated markets to a sponsor closing a deal. The lender's edge: origination relationships and workout control when things sour.
The questions that matter now
Floating rates transferred rate risk to borrowers — interest coverage ratios compressed sharply post-2022. Payment-in-kind (PIK) toggles and amend-and-extend activity are the stress indicators to watch; marks lag reality by construction, and the recovery assumptions (~70%, bank-loan-like) are untested at asset-class scale.
4 · AdvancedPricing & valuation
Valuation without markets
Loans are marked quarterly to "fair value" via matrix pricing: benchmark spread movements + borrower-specific credit assessment, overseen by valuation agents. The smoothing is structural — BDC marks trailed the 2022 syndicated-loan selloff by two quarters and half the amplitude. Analysis must therefore run on look-through fundamentals: portfolio interest coverage, fixed-charge coverage, PIK share, non-accruals, and vintage concentration.
Return decomposition
What the symbols mean
- rthe interest rate, per year
- Lleverage, or a loss given default
- Pa price, or a present value
- Sthe price of the underlying today
- Fthe forward or futures price
- Ra return
The debated term is \(\lambda(1-R)\): observed defaults have been benign, but the borrower cohort (small, levered, sponsor-owned, recession-untested) resembles high-yield's riskier half. Sceptics price the spread as illiquidity + complexity premium; enthusiasts as banking's abandoned margin. Both are partly right; the cycle will apportion.
Systemic angle
Regulators (Fed, BoE, IMF) now map bank exposure to private credit funds (subscription lines, fund leverage, insurer stakes) — the risk moved off bank balance sheets but is tethered back through financing. Insurance-owned managers matching illiquid credit to annuity liabilities (the Apollo/Athene template) are the structural innovation being stress-watched.
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.